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In an era where sustainability is not just a buzzword but a pressing necessity, the Reserve Bank of India (RBI) has been leveraging green bonds to fund environmentally sustainable projects. However, the lukewarm response to the November 2024 auction of ₹5,000 crore in sovereign green bonds has raised eyebrows. Despite their intent to signal India’s commitment to combating climate change, only ₹1,502 crore found takers at a yield of 6.79%. A staggering ₹3,498 crore was devolved onto primary dealers. What went wrong with a financial instrument that was once heralded as a green knight?

What Are Sovereign Green Bonds?

Sovereign green bonds are government-backed debt instruments aimed at raising funds for eco-friendly projects. Their proceeds are exclusively earmarked for ventures like renewable energy, clean transportation, or biodiversity conservation. Think of them as government securities with a conscience.

Green bonds debuted globally in 2007, with the European Investment Bank leading the charge. India joined the movement in January 2023, issuing ₹16,000 crore worth of sovereign green bonds under stringent guidelines. These bonds adhere to the International Capital Market Association’s Green Bond Principles, ensuring transparency and accountability in their use.

A Tale of Two Auctions

India’s first issuance of green bonds in January 2023 was a roaring success. Oversubscribed by over four times, the issuance demonstrated immense investor confidence. Public sector banks, insurers, and even international investors participated enthusiastically, buoyed by a yield just 5-6 basis points lower than comparable government securities.

Fast forward to November 2024, and the enthusiasm had all but disappeared. The stark contrast between the two auctions is a story of missed expectations and market misalignment.

What Went Wrong?

Yield Expectations

Green bonds inherently offer lower yields, often termed a “greenium,” because their purpose is to provide cheap financing for high-risk, unproven sustainability projects. However, investors were unwilling to accept these lower returns, especially in a climate where other instruments, like government securities, offered similar yields with better liquidity and fewer risks.

Liquidity Challenges

The secondary market for green bonds in India is newborn at best. Unlike the highly liquid market for standard government securities, green bonds have limited tradability. This means that investors are often locked into these bonds for the long haul, a less attractive proposition for those seeking flexibility.

As Vikas Goel, CEO of PNB Gilt, succinctly put it, “There is no sufficient outstanding in this bond, so there will be no liquidity. It’s like having another 10-year security but without the ability to trade it.”

Narrow Investor Base

India’s green bonds are primarily targeted at institutional investors, such as banks and insurers, leaving out retail investors entirely. Retail investors typically prefer high-liquidity, well-known products, and without significant incentives, green bonds fail to capture their interest.

Lack of Incentives

Unlike countries like Brazil and those in Europe, India does not mandate institutional allocations to ESG (Environmental, Social, and Governance) products or offer tax incentives for green bond investments. Without these measures, green bonds compete directly with regular government securities—and lose.

For example, Brazil ties its green bonds to national priorities, like Amazon preservation, making them more appealing. Europe’s regulatory frameworks drive ESG investments, ensuring demand even at lower yields.

Market Conditions

The broader economic environment also played a role. In a high-inflation, volatile market, investors prioritised financial returns over altruistic goals. Without clear financial incentives or regulatory mandates, even institutional investors showed limited enthusiasm.

A Global Perspective

Globally, the green bond market is booming. It reached $575 billion in 2023, thanks to robust regulatory support and financial incentives that make these instruments attractive despite their lower yields. In contrast, India’s green bond market is at a nascent stage, struggling to align its financial appeal with its sustainability objectives.

Why Green Bonds Still Matter

India’s climate finance needs are monumental. The country requires $170 billion annually to meet its climate goals, while actual flows stand at just $44 billion. Green bonds, though flawed in their current structure, remain a critical tool to bridge this gap. They symbolise India’s commitment to combating climate change and could 8be pivotal in funding sustainable projects if made more investor-friendly.

The Way Forward

The flop of the November 2024 green bond auction isn’t just a minor hiccup; it’s a wake-up call. To ensure the success of future issuances, policymakers need to rethink their approach:

1. Offer Tax Incentives: Providing tax breaks could attract both institutional and retail investors.
2. Improve Liquidity: Creating a robust secondary market would make green bonds more tradable and attractive.
3. Mandate Allocations: Requiring institutions to allocate a portion of their portfolios to ESG products could drive demand.
4. Broaden Participation: Educating and incentivising retail investors could expand the buyer base.
5. Highlight Impact: Linking bonds to tangible, high-visibility projects, like clean water access or solar energy, could improve their appeal.